Turkish Lira Slides as "Turkish Central Bank Loses Credibility"

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Markets were expecting to see a 50 basis point rise in the benchmark repurchase rate, however the central bank decided to keep rates on hold at 8%.

The overnight lending rate was raised by 75 basis points, as expected, while the overnight borrowing rate was not increased, dashing expectations for a 25 basis point rise.

"Overall, this is a disappointing move, as the central bank did the bear minimum to try and halt the decline in the lira. The central bank said that it would hike interest rates further, but only if the inflation outlook deteriorated. This could be a self-fulfilling prophecy, as today’s drop in the lira is likely to heap further upwards pressure on Turkey’s CPI rate, which climbed to 8.53% in December," says Kathleen Brooks at City Index.

Brooks says the CBT has lost credibility as today’s decision is likely to be viewed by the market as a politically motivated, rather than an economic one.

"The Finance Minister and President Erdogan have both said they don’t want to see higher interest rates due to the damage that it could do to the economy. We will have to wait for the 2016 GDP report, due in March, before we see to what extent the weaker lira is weighing on economic growth, and however, the future trajectory for the lira does not look good," says Brooks.

Brooks adds:

"When the independence of a central bank is threatened, as is the case in Turkey, the market’s trust is lost, which can weigh on a currency, as we are seeing today. However, Turkey has multiple issues, not least a lame duck central bank. Terrorism and the upcoming Constitutional Referendum are all likely to keep downward pressure on the lira in the near term.

Lira in a Tailspin

The Turkish Lira has been in a tailspin since October 2016 but it may recover on Tuesday if the Central Bank of Turkey (CBT) raise interest rates, as is widely expected.

The Lira’s descent has seen it reach an all-time low of 4.8116 to the Pound in the first week of January 2017.

The depreciation was due to a combination of heightened domestic security risks, elevated political uncertainty following an extension of a state of emergency for another three months and Parliamentary voting on the Executive Presidency and the disappointing December inflation data.

The GBP/TRY exchange rate has however since pared back to 4.70 in anticipation of potential CBT action.

“We expect the CBT to lift up its policy rates on Tuesday, January 24th,” says Deutsche Bank’s Kubilay Ozturk in a note released ahead of the event.

The Central Bank has already intervened directly in the market by selling Dollars for Lira but as this proved inadequate.

The CBT then changed tactic and on January 12 decided to cut off funding to the market through their weekly repurchase auction at the rate of 8%; instead leaving banks with only the late borrowing option at the rate of 10%.

One problem for the Lira is a conflict between Central Bank and high office.

President Recep Tayyip Erdogan is keen on keeping rates low, however, the CBT is at risk of losing all credibility unless it raises rates at tomorrow’s meeting , due to the Lira’s constant devaluation.

“The sharp liquidity tightening revived speculation that the Central Bank would finally act on rates, despite the very well-known pressure to keep the rates at the lowest possible levels by President Erdogan himself,” commented Ipek Ozkardeskaya is a senior market analyst at London Capital Group.

“The credibility of the CBT has taken a dreadful hit and avoiding to face the reality by acting secretly would only weaken investors’ confidence, even regarding its unpredictable amendments to its often inappropriate strategy,” added the analyst.

It seems even the President may have softened his stance after Erdogan’s officials hinted at a rate action too.

Analysts expect Turkey’s overnight lending rate to be raised by 75 basis points to 9.25%, the benchmark repurchases rate by 50 basis points to 8.50% and the overnight borrowing rate by 25 basis points to 7.50%.

The late lending rate should also be readjusted higher, if it becomes the bank’s new tool in emergency situations.

If anything more agressive than markets are forecasting is delivered then we could well see TRY climb higher.

What is for sure though that disappointment is not an option so any under-deliverance will be punished.

"Our economists expect a 75bp hike, which will likely see the TRY continue to depreciate. Such action, even if accompanied by a hike to the late liquidity-window, is likely to disappoint FX markets," says Kiran Kowshick, FX Strategist at UniCredit Bank in London.

UniCredit deem a 150bp hike as market-neutral. This would offer only short-term respite, offering opportunities to consider short exposure at better levels given the still large external financing requirement.

"A hike in excess of 300bp could result in a counter-trend TRY rally over a 1-3M horizon, similar to that seen in 4Q11 and 1Q14," says Kowshik.

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